Something that you will likely hear as a homeowner is the term “second mortgage” ― this type of home loan is secured by the value of your home. A second mortgage is a completely different loan from the original mortgage you obtained to buy your house. In many cases, a second mortgage takes the form of a Home Equity Loan (HEL), or a Home Equity Line of Credit (HELOC).
It is important to understand that a second mortgage is always subordinate to a first mortgage. This means that if something happens and you end up defaulting on both loans, the first mortgage must be paid off first ― and the lender for the first mortgage will receive money before the lender for the second mortgage does. As a result, you’ll notice that second mortgages generally have higher interest rates than first mortgages.
There are several reasons homeowners may have for using a second mortgage loan ― these can include financing college education, making home improvements or renovations, paying for a wedding, consolidating credit card debt, or even going on a dream vacation. When you have access to your home’s equity, there are numerous possibilities.
Qualifying for a Second Mortgage
In order to obtain a second mortgage, you need to have sufficient equity in your home. Equity is basically ownership that’s built when you pay down the principal balance on your mortgage loan, and when your property appreciates in value. Equity is the difference between what you still owe on the home, and the home’s market value.
For Example: If your home is valued at $200,000 and you still owe $150,000 on the mortgage loan, you have $50,000 of equity (or “ownership”) in your home. That $50,000 of equity is what may be used when considering second mortgage.
However, most lenders will not issue a second mortgage for the total amount of equity in your home. Instead, they will require some cushioning to reduce their risk, which may restrict the amount you can borrow. (If you use the example above, your second mortgage would probably be limited to $20,000 – $40,000 depending on the lender.)
Since a second mortgage is an entirely different loan, separate from the first mortgage, it will come with the same kinds of fees as any other home loan ― including processing fees, origination fees, closing costs, etc. Make sure that you keep this in mind as you shop around for a second mortgage.
There are also third mortgages and fourth mortgages, but these are less common since they require even more borrowing.